OCEAN CITY – While certain commodities, such as oil and precious metals, took a tumble last fall with the rest of the market, we feel their prospects are looking brighter. Investors may want to take note. Rising commodity prices may prove a well-placed hedge against the possibility of inflation — and an outsized opportunity to capitalize on growth in emerging markets.
"We’re looking at an astonishing recovery in demand for commodities," says Francisco Blanch, head of global commodities research at BofA Merrill Lynch Global Research. China, India, Brazil and Indonesia will be well positioned to drive this recovery as they come out of the economic crisis, he says, with plenty of capital reserves, skilled labor and potential for productivity gains. And as productivity rises in these growth economies, so will their investment in infrastructure, fueling an even bigger appetite for such raw materials as oil and metals.
At the same time, the fiscal and monetary stimulus packages that have been put in place all around the world are injecting much-needed liquidity into these capital-starved emerging markets. This added cash flow is giving its recipients more money to spend on oil, metals and other raw materials. Because the supply of many commodities remains constrained, their prices are likely to rise. "This is a case of selective inflation," says Blanch. "If you give away money, at some point quantities of materials you can buy with money will run out. That’s when prices rise very quickly."
Not all commodities are likely to bounce back at the same pace, and limitations in supply will strongly influence the pace of their recovery. The demand for oil is still relatively weak, for example, and Blanch estimates that it could take two years or more for the intense competition for crude oil to drive prices above $100 per barrel. Oil-drilling companies that slashed production as much as 50% in response to declining consumer demand during the economic downturn are still running well below capacity. Blanch sees oil prices ranging between $70 to $85 per barrel for the next few months. "But as we move into the second half of 2010, price action will get very, very strong. We see a price of $94 per barrel in the fourth quarter of 2010." A more immediate recovery is expected for metals. BofA Merrill Lynch Global Research recently raised 2009 and 2010 price forecasts for industrial metals across the board, citing surging demand by China and core free-market economies in the Organisation for Economic Co-operation and Development (OECD), including Germany, Japan and the United States. Copper, nickel and zinc will likely fare best in the short term due to anticipated supply shortages. Conversely, aluminum offers less potential, given the abundance of inventory coupled with healthy production capacity. Blanch expects copper, which remains in short supply, to be in deficit by the end of next year, a development that is likely to drive up prices.
The near- and long-term outlook is also strong for soft commodities, generally defined as products such as coffee and cotton that are grown rather than mined. These agricultural commodities can play an important role in a portfolio. Their correspondence with other asset classes tends to be low, and they may serve as a vital hedge against inflation or against turbulence in the equity or bond markets.
In short, commodities could prove an opportune way to gain exposure to global growth while adding an important balance to your asset mix of equities and bonds.
(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)